“It also confirms the early warning over weakening end-user demand given by developments in the global chemical industry since the start of the year. Capacity Utilisation was down again in September as end-user demand slowed. And this pattern has continued into early November, as shown by our own Volume Proxy.”

The same phenomenon had occurred before the 2008 Crisis, of course, as described in The Crystal Blog. I wrote regularly here, in the Financial Times and elsewhere about the near-certainty that we were heading for a major financial crisis. Yet very few people took any notice.

So why did Apple shares suddenly crash 10% on 3 January, as the chart shows? Everything that Apple reported was already known. After all, when I wrote in November, I was using published data from Strategy Analytics which was available to anyone on their website.

The answer, unfortunately, is that markets have lost their key role of price discovery. Central banks have deliberately destroyed it with their stimulus programmes, in the belief that a strong stock market will lead to a strong economy. And this has been going on for a long time, as newly released Federal Reserve minutes confirmed last week:

The result is that few investors now bother to analyse what is happening in the real world.

They believe they don’t need to, as the Fed will always be there, watching their backs. So “Bad News is Good News”, because it means the Fed and other Western central banks will immediately print more money to support stock markets.

And there is even a new concept, ‘Modern Monetary Theory’ (MMT), to justify what they are doing.

THE MAGIC MONEY TREE PROVIDES ALL THE MONEY WE NEED

There are 3 key points that are relevant to the Modern Monetary Theory:

The Federal government can print its own money, and does this all the time

The Federal government can always roll over the debt that this money-printing creates

The Federal government can’t ever go bankrupt, because of the above 2 points

The scholars only differ on one point. One set believes that pumping up the stock market is therefore a legitimate role for the central bank. As then Fed Chairman Ben Bernanke argued in November 2010:

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

“MMT logically argues as a consequence that there is no such thing as tax and spend when considering the activity of the government in the economy; there can only be spend and tax.”

The result is that almost nobody talks about debt any more, and the need to repay it. Whenever I talk about this, I am told – as in 2006-8 – that “I don’t understand”. This may be true. But it may instead be true that, as I noted last month:

“Whilst Apple won’t go bankrupt any time soon, weaker companies in its supply chain certainly face this risk – as do other companies dependent on sales in China. And as their sales volumes and profits start to fall, investors similarly risk finding that large numbers of companies with “Triple B” ratings have suddenly been re-rated as “Junk”:

Bianco Research suggest that 14% of companies in the S&P 1500 are zombies, with their earnings unable to cover interest expenses

The Bank of International Settlements has already warned that Western central banks stimulus lending means that >10% of US/EU firms currently “rely on rolling over loans as their interest bill exceeds their EBIT. They are most likely to fail as liquidity starts to dry up”.

I fear the coming global recession will expose the wishful thinking behind the magic of the central banks’ money trees.

Many indicators are now pointing towards a global downturn in the economy, along with paradigm shifts in demand patterns. CEOs need to urgently build resilient business models to survive and prosper in this New Normal world, as I discuss in my 2019 Outlook and video interview with ICIS.

Global recession is the obvious risk as we start 2019. Last year’s hopes for a synchronised global recovery now seem just a distant memory. Instead, they have been replaced by fears of a synchronised global downturn.

Capacity Utilisation in the global chemical industry is the best leading indicator that we have for the global economy. And latest data from the American Chemistry Council confirms that the downtrend is now well-established. It is also clear that key areas for chemical demand and the global economy such as autos, housing and electronics moved into decline during the second half of 2018.

In addition, however, it seems likely that we are now seeing a generational change take place in demand patterns:

From the 1980s onwards, the demand surge caused by the arrival of the BabyBoomers into the Wealth Creating 25 – 54 cohort led to the rise of globalisation, as companies focused on creating new sources of supply to meet their needs

At the same time the collapse of fertility rates after 1970 led to the emergence of 2-income families for the first time, as women often chose to go back into the workforce after childbirth. In turn, this helped to create a new and highly profitable mid-market for “affordable luxury”

Today, however, only the youngest Boomers are still in this critical generation for demand growth. Older Boomers have already moved into the lower-spending, lower-earning 55+ age group, whilst the younger millennials prefer to focus on “experiences” and don’t share their parents’ love of accumulating “stuff”

The real winners over the next few years will therefore be companies who not only survive the coming economic downturn, but also reposition themselves to meet these changing demand patterns. A more service-based chemical industry is likely to emerge as a result, with sustainability and affordability replacing globalisation and affordable luxury as the key drivers for revenue and profit growth.

Samsung’s market share has declined from a third in 2013 to a fifth today, as its mid-market positioning leaves it without a clear value proposition for consumers

China’s Top 3 players have meanwhile soared from just a 12% market share to 29% today, powered by their low-cost positioning

Apple’s market share has remained very stable, as it has focused on the top end of the market, prioritising price over volume

“Others”, also usually without a clear value proposition, have seen their share drop to just 36% from a peak of 46% in Q3 2016

China remains the world’s largest smartphone market, with 103 million phones sold in Q3. But its volume was down 8% compared to Q3 2017, as the stimulus programmes continue to slow. As the Counterpoint chart shows, the market is now consolidating around a few winners:

Huawei are emerging as the market leader with a 23% share

Vivo and Oppo remain key challengers at 21%

But “Others” have dropped to 13%, and Samsung has almost disappeared at just 1%

As Counterpoint note, the top 5 brands now hold 86% of the market:

“The Chinese smartphone market is saturated with accelerated market consolidation. The competition in 2018 is almost a zero-sum game for the top five players. It is challenging however, even for the leading brands to create clear product differentiation. In Q3, only Huawei and vivo managed to achieve positive YoY growth among the top 5 brands.”

Meanwhile, of course, Apple continue to dominate the premium segment after the launch of the new iPhones in September.

This divergence between low-cost and premium will no doubt spread across the rest of the global market as the downturn continues. And the main growth is likely to be in the low-cost area.

India, for example, saw volume grew 5% versus Q3 2017. But with average per capita income less than $2000, price is all-important. Reliance Jio’s ultra-low pricing strategy has been critical in making bandwidth affordable, and there are now over 400 million smartphone users in the country.

But iPhone sales are actually falling, and will be down by a third to just 2 million this year. Functional phones in the $150-$250 price segment are driving sales growth, via online sales. Q4 is expected to see these grow 65% to reach 50 million, due to their 50%-60% discounts.

The smartphone market thus continues to confirm that the BabyBoomer-led SuperCycle is over. As the chart shows, this created a new and highly profitable mid-market from the mid-1980s:

Before then, companies had competed on the basis of price or perceived value

But from the mid-1980s onwards, the mid-market became the most profitable sector

Now, with the Boomers retiring and stimulus programmes ended, we are going back to basics again

Instead, the market is segmenting again on the basis of price or perceived value. Chinese players compete on price, while Apple focuses on profit and is moving up-market. this means that previously profitable market leaders such as Samsung are slowly disappearing along with the mid-market segment that they supplied.

These very different strategies highlight the new world ahead for consumer markets and those who supply them.

The 3 Chinese brands (Huawei, OPPO, Xiaomi) have collectively taken top position with 27% of the market

Samsung has slipped into 2nd place with 23%, whilst Apple is at 15%

Total volume at 345m was down 2% versus 2017 and back at 2015 levels, as Strategy Analytics note:

“Samsung is holding steady in its core markets of North America, Western Europe and South Korea, but the company is facing intense competitive pressure in China and India from rivals such as Xiaomi. Apple volume grew 3%.

The key to Q1’s decline was the collapse in China’s market, where sales fell 19% to 91m, and were back at 2013 levels according to Canalys data. And as the chart shows, the 4 main players are consolidating their position:

Huawei grew market share to 24% from 18%; OPPO grew from 17% to 19%

Vivo grew from 15% to 17%, whilst Xiaomi jumped 8% to 13%. And as Canalys note:

“There is a sense of fatigue in the market. The level of competition has forced every vendor to imitate the others’ product portfolios and go-to-market strategies. But the costs of marketing and channel management in a country as big as China are huge, and only vendors that have reached a certain size can cope.”

Xiaomi’s growth is due to its focus on the sub-RMB1000 level ($160). Its recent launch of cheap up-market phones will put more pressure on competitors and further drive consolidation in the market.

SMARTPHONE MARKET’S POLARISATION CONFIRMS THE GLOBAL TREND

It is, of course, no accident that China’s downturn has ended global market growth. Its vast stimulus programme after 2008’s financial crisis meant that it became the growth engine for the global economy. But now President Xi’s resolve to make “deleveraging” one of his “3 tough challenges” is changing the rules of the game, again:

As the chart shows, the Boomer-led SuperCycle created a new and highly profitable mid-market

Before then, companies had competed on the basis of price or perceived value

But from the mid-1980s onwards, the mid-market became the most profitable sector

Now, with the Boomers retiring and stimulus programmes ended, we are going back to basics again

The vastly different strategies of Apple and Xiaomi highlight the new world ahead

Apple CEO, Tim Cook, has deliberately turned his back on the mid-market, positioning the new iPhone X at the $1000 price point, where it has consistently outsold the cheaper iPhone 8 and iPhone 8Plus. In turn, this led profits to jump 25%. As a result, Apple is the clear leader in the high-end sector with its relatively niche products and high margins. As the Financial Times reports:

“iPhone unit sales of 52m were up only 3% by volume but the product’s revenues jumped 14%, as the iPhone X drove its average selling price up by $73 compared with a year ago, to $728.”

Apple’s performance highlighted the new strategy:

Its China revenues rose 21% and the iPhone X was the top selling smartphone

Around a quarter of US consumers sold their old smartphone when upgrading last year

iPhones will likely hold their value well, making them more valuable when resold

Similarly, Xiaomi’s success in China highlighted the opportunity in the mass-market. Its market share jumped to 13% as it aimed to make a net profit margin of just 5% on its $100 – $160 phones.

INVESTORS NEED TO WATCH FOR BANKRUPTCIES AS CONSOLIDATION REVS UP
The free money provided by the central banks since 2008 has had two key effects:

It has prolonged the reign of the mid-market as consumers have been able to borrow cheaply

It has allowed mid-market companies to borrow heavily and build up major debt

Now, both of these trends are reversing. Consumer spending is increasingly being driven by income, rather than borrowing. Companies are seeing interest rates rise on their debt: even worse, those who borrowed to take advantage of low US rates are seeing repayments rise as the US$ rises again.

Investors need to be very careful about where they place their bets for the future. And companies need to check out their business partners’ strategies. Falling volumes and higher interest/debt costs will lead to a wave of bankruptcies.

Most analysts are ignoring the changes underway in China. As with subprime, they will soon argue that “nobody could have seen this coming”. But in reality, there are always warning signs. The global smartphone market has been the great success story of the stimulus era. Its paradigm shift is highlighting the likely “surprises” that lie ahead.

Global smartphone sales have seen major growth until recently as consumers fell in love with going mobile, as the chart shows:

In the critical Q4 period they jumped from 290m in 2013 to 380m in 2014, 405m in 2015 and 439m in 2016

But they then fell 9% in Q4 last year, according to Strategy Analytics data. They note that:

“It was the biggest annual fall in smartphone history (and) …. was caused by a collapse in the huge China market, where demand fell 16% annually due to longer replacement rates, fewer operator subsidies and a general lack of wow models.”

Even more revealing was that only Xiaomi of the Top 5 vendors increased their volume. Apple lost 1m sales, Samsung lost 3m, Huawei lost 4m, whilst even OPPO only managed to maintain its volume. And Xiaomi only did well because they were recovering from their 2016 collapse, when their share crashed to just 3.35% from 5% in Q4 2015.

Chinese companies were, however, the real winners during 2017 as the price war intensified, as the second chart confirms:

China’s top 3 vendors now supply a quarter of the global market – compared to less than a tenth in 2013

Samsung have been the main loser, with their share falling from over a third of the market to less than a fifth

The rise of the Chinese vendors is great news for consumers, but very bad news for their competitors, as the third chart confirms. It highlights how revenues are now being squeezed for most vendors as the Chinese ramp up their volume. Only Apple has avoided the carnage by heading defiantly up-market, with its average handset price now close to $800.

The issue is the very different nature of the smartphone market in the major emerging economies, where incomes are much lower than in the West and it is very rare for carriers to subsidise handset sales over the life of the contract. In India, for example, the typical smartphone sells for less than $200, whilst Apple has less than 2% of the market.

2017 therefore marked a crucial turning point in the market, as I forecasted when reviewing 2016 data a year ago:

“The issue is that 3.1bn people now own smartphones, and the other 4.2bn can’t afford them. So inevitably, the market is going to focus more and more on price. Of course, millions of people will still want to own an iPhone or Galaxy. But price will become the deciding feature for many people.”

2018 seems likely to see pricing pressure intensify, now that the Chinese market has gone ex-growth. India is likely to be a critical battleground after Xiaomi’s success there in 2017, which was key to its nearly doubling global sales. As analysts IDC noted:

“Brands outside the Top 5 struggled to maintain momentum as value brands such as Honor, Vivo, Xiaomi, and OPPO offered incredible competition at the low end.”

OPPO is likely to be particularly aggressive as it saw no growth in 2017 after doubling its sales in 2016, whilst Xiaomi is unlikely to risk a second slip-up on volume. In turn, this makes it likely that Samsung’s mid-market positioning will come under major pressure from Chinese competition in key markets such as China and India.

Apple must now intensify its efforts to move into application-based markets such as healthcare and other services. It has been building its position over the past 3 years, and has a vast cash-pile from its smartphone profits to fund the necessary shift away from hardware sales. Samsung’s future looks less rosy, however, given that Chinese vendors have been able to produce smartphones for as little as $20 for the past 2 years.

And as I noted back in May 2015:

“The smartphone market is not alone is facing these New Normal challenges. They are coming to the online and High Street stores near all of us, if they haven’t already arrived.“

China’s Top 3 manufacturers – Huawei, OPPO and Vivo – captured top position in global smartphone sales for the first time in Q1. As the chart shows:

□ They took 22.9% of the market compared to 22.7% for Samsung and 14.4% for Apple
□ In terms of individual smartphone sales, OPPO’s R9s smartphone reached the No. 3 position worldwide
□ It was still behind Apple’s iPhone 7 and iPhone 7Plus, but ahead of Samsung’s aging Galaxy J3 and J5 models

“OPPO is largely unknown in the Western world, but its brand is wildly popular in China and growing rapidly across India. The R9s is OPPO’s flagship 4G device with key features such as dual-SIM connectivity and fingerprint security.”

“The issue is that 3.1bn people now own smartphones, and the other 4.2bn can’t afford them. So inevitably, the market is going to focus more and more on price. Of course, millions of people will still want to own an iPhone or Galaxy. But price will become the deciding feature for many people.”

The impact can be seen throughout the smartphone eco-system. Consolidation is the normal response when market growth begins to slow. As the second chart confirms, Q1 sales at 353m were only up 2% versus Q1 2015, when the global market began to plateau. The low-cost Chinese players are now gaining share in the mass-market versus Apple and Samsung as premium pricing disappears, and the micro-vendors are also being squeeezed:

□ This price pressure led to Apple losing out in China to cheaper models with similar features
□ The “Top 100+” micro-vendors were also squeezed, and were collectively down 8% versus Q1 2016
□ The success of low-cost larger producers meant the “Top 30+” gained 8% versus Q1 2016

Samsung are most at risk at the moment, as they recover from the Galaxy Note 7 problems. Their sales fell around 60% in China – the world’s largest market. They are now launching the new Galaxy S8 model to rebuild their position, but will also face strong competition in H2 with Apple’s 10th anniversary iPhone.

The same process of consolidation has, of course, already played out in the smartphone software market, where Google’s Android system is now the dominant player. It has 86% of the market, with only Apple’s iOS system (14%) still competing against it. Apple therefore has to get everything right with the 10th anniversary iPhone – if it fails to excite, then Apple’s entire business model of combining hardware with software will be at risk.